China sees the wrong kind of growth

Uptick in public investment and real estate push up GDP, but may fuel bubbles

ISSAKU HARADA, Nikkei staff writer

BEIJING China's economy logged its second straight quarter of accelerating growth in January-March, up 6.9% on the year, according to preliminary statistics.

That improvement is good news for President Xi Jinping, who aims to stabilize economic growth through government spending ahead of the National Congress of the Communist Party, a key party gathering to be held this autumn.

The bad news is that the engines powering the current growth spurt -- increased public investment and higher real estate sales -- can easily lead to asset bubbles if left unchecked.

BIG SHOTS Investment in infrastructure projects, such as roads and airports, soared 23.5%. "Regional government officials and bureaucrats upped their investments in order to score points with economic growth" before the Communist Party reshuffles its leadership this autumn, a party-affiliated source said.

Government spending rose 21% for the quarter. Sales of heavy construction equipment nearly doubled to 40,000 units, and the rise in demand spread to other industries as well.

A China office of a major Japanese steelmaker reportedly got a call this spring from the head of procurement at a Chinese construction company, offering to buy steel even if it were a little pricey.

The supply-demand gap for Chinese steel has narrowed sharply as the nation seeks to cut excess output capacity just as regional governments are stepping up spending on infrastructure. Prices have climbed 20-30% since last summer. Crude steel output rose 4.6% on the year for the quarter, more than the 1.2% growth seen for all of 2016. But some Chinese companies are still struggling to meet demand.

"This has never happened before," an executive at a Japanese steelmaker said.

Real estate was the other major growth driver. Development investment grew 9.1% for the first quarter, faster than the 6.9% for all of 2016. Commercial property sales shot up 19.5% by floor space.

Beijing has tightened restrictions on investing abroad since late last year in an effort to combat capital flight. Now money is no longer flowing out but is returning to settle in domestic real estate, said finance professor Chen Zhiwu of Yale University.

Real estate investment accounted for around 7% of China's growth in the first quarter, according to figures from the National Bureau of Statistics. When associated spending on such durable goods as furniture and appliances is factored in, the real contribution was likely bigger.

RISKY BUSINESS Growth driven by infrastructure spending and real estate has major side effects. For one, condominium prices in Beijing, Shanghai and Shenzhen have apparently topped those seen in Tokyo in the days of Japan's bubble economy.

And if China slows its reductions in steel production capacity to meet current demand, there is the risk of oversupply problems re-emerging later.

More than half of small and midsize businesses are in difficult financial straits, according to a March survey by the statistics bureau. Bond defaults remain high as well. Small and midsize banks, forced to take on more short-term debt, are also investing more in medium- and long-term bonds and wealth management products.

A plunge in asset prices would hurt the country's financial system. Premier Li Keqiang spoke of financial risks in his annual Report on the Work of the Government in March. The People's Bank of China has also pared back its heavy monetary easing and has been raising short-term interest rates. The one-year lending rate now stands 1.5 percentage points above where it was in early 2016. The central bank has also been tightening liquidity in the market. The PBOC's monetary policy tuning could put pressure on economic growth in the second half of this year.

Brian Jackson, China economist at IHS Global Insight, said, "A steady deceleration in the real estate sector should take hold from the second quarter onward, due to high base effects and policy tightening, which will create an additional drag for both the services and construction components of GDP."